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Financial depth

Key Terms Explained

Financial depth

Financial depth captures the financial sector relative to the economy. It is the size of banks, other financial institutions, and financial markets in a country, taken together and compared to a measure of economic output.
A proxy variable that has received much attention in the empirical literature in this regard is private credit relative to gross domestic product (GDP). More specifically, the variable is defined as domestic private credit to the real sector by deposit money banks as percentage of local currency GDP.  The private credit, therefore, excludes credit issued to governments, government agencies, and public enterprises. It also excludes credit issued by central banks.

Private credit to GDP differs widely across countries, and it correlates strongly with income level. For example, private credit to GDP in high-income countries is 103 percent in high-income countries, more than 4 times the average ratio in low-income countries. Based on this measure, economies with deep financial systems include many of those in Europe; Canada, Australia, and South Africa are also among those in the highest quartile in terms of private credit to GDP. China’s financial system is also in the highest quartile in terms of this measure, higher than other major emerging markets such as Russia, Brazil, and India. The United States’ financial system, while above average, is not as deep as China’s.  This reflects in part the more market-based nature of the U.S. financial system. 

Financial depth, approximated by private credit to GDP, has a strong statistical link to long-term economic growth; it is also closely linked to poverty reduction. For example, the annual average value of private credit across countries was 39 percent with a standard deviation of 36 percent. Averaging over 1980–2010, private credit of financial institutions was less than 10 percent of GDP in Angola, Cambodia, and Yemen, while exceeding 85 percent of GDP in Austria, China, and the United Kingdom. For financial markets, research has shown that the trading of ownership claims on firms in an economy is closely tied to the rate of economic development. For instance, the mean value of stock value traded is about 29 percent of GDP. In Armenia, Tanzania, and Uruguay, stock value traded annually averaged less than 0.23 percent over the 1980‐2008 sample (10th percentile). In contrast, stock value traded averaged over 75 percent in China (both Mainland and Hong Kong SAR), Saudi Arabia, Switzerland, and the Unites States (90th percentile).

A very high ratio of private sector credit to GDP is not necessarily a good thing. Indeed, all the 8 countries with the highest ratios of private sector credit to GDP as of 2010 (Cyprus, Ireland, Spain, Netherlands, Portugal, United Kingdom, Luxembourg, and Switzerland, going from the highest to the lowest) had a major crisis episode since 2008. For more on the cross-country relationships between financial depth, economic development and poverty reduction, see, for example King and Levine 1993, Demirgüç-Kunt and Levine 2008, and World Bank 2012.

An alternative to private credit to GDP is total banking assets to GDP, a variable that is also included in the Global Financial Development Database. It is arguably a more comprehensive measure of size, because it includes not only credit to private sector, but also credit to government as well as bank assets other than credit. However, it is available for a smaller number of economies and has been used less extensively in the literature on financial development. In any case, the two variables are rather closely correlated (with a correlation coefficient of about 0.9 over the whole sample).

Despite the empirical literature’s focus on banks (due to data availability), measures of financial depth should ideally go beyond just banks. Indeed, the recent crisis has highlighted issues in non-bank financial institutions (NBFIs). The coverage of NBFIs by data is much less comprehensive than that of banks. Nonetheless, to acknowledge this point, the Global Financial Development Databaseincludes total assets of NBFIs to GDP, which includes pension fund assets to GDP, mutual fund assets to GDP, insurance company assets to GDP, insurance premiums (life) to GDP, and insurance premiums (non-life) to GDP.

For financial markets, earlier work by Levine and Zervos (1998) indicates that the trading of ownership claims on firms in an economy is closely tied to the rate of economic development. To approximate the size of stock markets, a common choice in the literature is stock market capitalization to GDP. For bond markets, a commonly used proxy for size is the outstanding volume of private debt securities to GDP. The sum of these two provides a rough indication of the relative size of the financial markets in various countries. There is substantial variation in this indicator among countries, by size and by income level. For example, over the 2008-2010 period, the world-wide average value of this ratio was 131 percent, but individual country observations ranged from less than 1 percent to 533 percent. The average for developed economies was 151 percent, while the average for developing economies was about a half, at 76 percent. Also, in bigger countries, financial markets tend to play a relatively larger role relative to the size of the economy.  Countries in the highest quartile of the world-wide distribution include not only the United States, Canada, Japan, and other major developed economies, but for example also China and Malaysia.

The size of financial institutions relative to the size of financial markets is often called the financial structures. A large literature is devoted to the topic of whether and under which conditions the mixture of financial institutions and financial markets in an economy exerts an influence on economic development (for an overview, see World Bank 2012). Financial structure differs markedly across economies. Over the full sample period, the annual average value of the financial structure ratio is 279. Countries such as Australia, India, Singapore, and Sweden have this ratio at or below 2.35 (10th percentile), while Bolivia, Bulgaria, Serbia, and Uganda are examples of countries where this ratio is over 356 (90th percentile).

Suggested reading:

Čihák, Martin, Asli Demirgüç-Kunt, Erik Feyen, and Ross Levine. 2012. “Benchmarking Financial Development Around the World.” Policy  Research Working Paper 6175, World Bank, Washington, DC.

Demirgüç-Kunt, Asli, and Ross Levine. 2008. “Finance, Financial Sector Policies, and Long-Run Growth.” M. Spence Growth Commission Background Paper 11, World Bank, Washington, DC.

Demirgüç-Kunt, Asli, Erik Feyen, and Ross Levine. 2011. “The Evolving Importance of Banks and Securities Markets.” Policy Research Working Paper 5805, World Bank, Washington, DC.

King, Robert, and Ross Levine, 1993, "Finance, Entrepreneurship, and Growth: Theory and Evidence," Journal of Monetary Economics 32(3), December, pp. 513-542.

Levine, Ross, and Sara Zervos. 1998. “Stock Markets, Banks, and Economic Growth.” American Economic Review 88: 537–58.

World Bank. 2012. Global Financial Development Report 2013: Rethinking the Role of the State in Finance. World Bank, Washington, DC (http://www.worldbank.org/financialdevelopment).




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